Bulls Return to Unloved Europe

Euro-zone companies deriving their revenues at home suddenly look like defensive plays.

Agence France-Presse/Getty Images

PARIS–Is it time to re-think returns in the euro-zone?

New analysis shows that European companies who derive most of their revenues from the fragile euro zone are enjoying improvements in price performance, while equity markets in peripheral Europe worst hit by the euro-zone crisis are also outperforming markets are the core.

The trend has been striking, at least so far this year.

A selection of stocks representing Europe’s export champions – i.e. those who derive a significant portion of revenue outside the continent — lost 2% in the first five weeks of the year. By contrast, a selection of European stocks most exposed to the euro-zone’s weak economy and financial problems gained 3%, according to Gavekal, a research and investment firm based in Hong Kong.

“With financial and cyclical conditions improving considerably in the euro zone, and risks rising in [emerging markets], the most domestic [focused] euro-zone companies now look more and more like the new defensive plays,” said Francois-Xavier Chauchat, an economist at GaveKal.

Betting on euro-zone focused companies is a way to avoid indirect exposure to emerging markets via the big European multinational corporations. Many of those are exposed to more sluggish-than-expected growth in these countries as well as sharp falls in currencies like the Turkish Lira and South Africa rand against the euro.

Among the top-10 best performing large-capitalization stocks in the euro-zone this year are Spain’s CaixaBank, up 24%, Telecom Italia, up 18%, Italian lender Intesa Sanpaolo, up 16%, Spanish rival Bankia, up 12%, and Italian electricity company Enel, up 11%.

Similarly, the best-performing euro-zone stock markets so far this year, judged by benchmark indexes, are in the region’s southern periphery, plus Ireland, all countries worst hit by the financial crisis. The market in Athens is up 8.0%. Dublin is up 6.0%, Lisbon, up 4.9%, Milan up 3.2%. Madrid is up just 0.4% but that is still better than the 1.5% decline in Paris’ CAC-40 index and the 2.8% drop in Frankfurt’s DAX index

“Peripheral equity markets… we believe will provide the best returns during 2014,” said Ian Scott and Dennis Jose, equity strategists at Barclays, in a recent report. “A benign cost environment coupled with a modest recovery should provide a bigger boost to profits that the consensus currently suggests,” they said.

The poorer relative performance of the major markets in Paris, Frankfurt and London does partly reflect the clustering of Europe’s biggest, most internationally-exposed firms on those exchanges. For example, in Paris, around 72% of revenues from CAC-40 companies come from outside France, according to analysis by Swiss Life.

Global companies such as brewer Anheuser-Busch InBev’s shares are down 7.3% this year, Anglo-Dutch consumer goods group Unilever is down 5.3%, dairy-products supplier Danone is down 5.1% and auto-maker Volkswagen AG is down 7.0%. They derive large chunks of their revenues from Asia and South America. The falling value of some emerging-markets currencies are also crimping returns for Europe’s multinational corporations.

By the same token, prospects are looking up for those European-focused banks and utilities with cleaned-up balance sheets as well as industrial and consumer-goods companies, particularly as wage inflation inside the euro zone remains contained, say analysts.

Equity strategists at Deutsche Bank, also bullish on southern Europe this year, for the similar reasons of a domestic-led economy recovery amid low inflation, reckon some stocks to watch are Italian banks Intesa and Mediolanum, Spanish toll-road operator Abertis, and Italian media company Mediaset and insurer Generali.

“The main downside risks now lie outside the euro-zone,” said GaveKal’s Mr. Chauchat.